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Managing Your Retirement Nest Egg

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Do you have a plan for how to draw down that 401(k) retirement money? For millions of Americans, the answer is no! While 401(k) plans usually offer a defined array of investment choices, online tools and other guidance, there is no such system in place for when workers retire.

With the major transition of employer-provided retirement benefits from fixed pensions, which the employer provides based upon one’s salary and years of service, to 401(k) and other types of plans that the employee has the responsibility of funding, participation in these programs can make the difference between retirement success or failure.

In the old days, many Americans had a defined benefit (DB) pension that paid them a steady guaranteed income in retirement. But the pension landscape has shifted dramatically: Now US retirement assets are in self-directed defined contribution (DC) plans, such as 401(k)s and individual retirement accounts (IRAs) – These DC plans and IRAs do offer millions the chance to build up and control their own nest eggs, but what they don’t offer is a guaranteed income in retirement.

Instead, retirees must manage their nest eggs themselves and hope that their decisions – how much to save, where to invest, and how much to take out each year – and the ups and downs of the market, will permit their money to last as long as they do.  By taking action now — via saving and planning for retirement — individuals can help ensure that they’re able to embrace this next phase of life. They can also reduce the stress increasingly associated with not having enough money to retire.”

By developing portfolios that consist of a variety of types of assets, we reduce the likelihood of losses in the overall portfolio. Specifically, bonds and other fixed accounts allow for the accumulation of wealth with less risk of loss while stock funds provide us with the opportunity for the growth of capital over time.

However, now is a particularly dicey time to be loading up on bonds. If interest rates rise by just 1 or 2 percentage points over the next few years, there will be big losses in the value of some bond portfolios. There used to be a simple rule for retirement savers: The percentage of bonds in your portfolio should match your age. So a 60-year-old would have 60 percent of her retirement stake in bonds.

The idea was that, as you aged, you should use bonds—which offer dependable payouts and rarely default—to shield more of your money from the wild swings of the stock market, even if that meant sacrificing potential investment gains. But today, in an era of ultralow interest rates and longer life spans, that one-size-fits-all approach won’t work for many people nearing retirement.

Many people are starting to use annuities to protect themselves from an economic downturn and to provide a guaranteed income.  The words — “income objectives” and “minimize the risk of a participant falling short” — pretty much explain how using annuities for retirement planning works, whether inside a qualified plan or outside (in the individual retail market).  They’re about the only way that investors can manage their mortality risk — living longer — and maintain the income they need for the rest of their lives.

Americans are reasonably good at estimating their expenses at retirement, they tend to underestimate the impact of inflation later in retirement. Many expect their expenses to remain flat throughout. Most people are withdrawing their money too quickly, leaving little or nothing for their final years, partly because they underestimate how long they are likely to live and partly because they do not have enough savings

People shouldn’t be expected to estimate how long they will live or what inflation will occur. How can a couple know, many years in advance, what they might need to live on in retirement? What will be their basic food, shelter, clothing, health care, and transportation expenses, as well as the additional discretionary spending on travel, entertainment, etc.?

People who have a pension that provides guaranteed lifetime income, can afford to keep more money in stocks.  Annuities are like a pension, they offer the security of guaranteed lifetime income, letting people take more risks with the rest of their portfolio.  Annuities provide peace of mind for people scared of running out of money.  It’s logical mathematically to invest the balance in more volatile assets; and emotionally, having an annuity makes it more palatable because you have a baseline coming in.

Traditional investments, like stocks, bonds and real estate, only provide a couple of sources of income: interest, dividends or capital gains. An annuity provides a potential fourth form of income: a mortality return, which is unique to an annuity and makes it very attractive.

Annuities can provide the legal safety net needed to fully protect their assets.  In addition, State guaranty associations provide a safety net to protect money in insurance policies and annuities if the insurer becomes insolvent, much like FDIC insurance.  Fixed annuities are the only product on the planet that provide both of these benefits.

In many states, annuities are fully protected and shielded from creditors and frivolous lawsuits. For many, this is a big deal since many seniors today are constant targets. Many people that have a thriving business model, like high paid surgeons, executives, and entrepreneurs, are only looking for principal and creditor protection.

If you would like to have a reliable source of lifetime income beyond what you’ll get from Social Security, it makes sense to at least think about putting some (but not all) of your savings in an income annuity.  This gives you a roadmap to help manage their financial life beyond retirement.

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Friday, March 27th, 2015 Wealth Management Comments Off

Retirement Adventure and Discovery

Retirement is a great time for adventure and discovery, but you need to make sure you’re prepared for the challenges you will face over those 20 to 40 years.  Some people feel like the Great Recession ended years ago, while others feel it’s still in process. Retirees are determined not to be financially strapped when the time comes to retire.

Now that retirement is here (or near), how do you create an income plan from your savings?  Put money into your 401(k), contribute to your individual retirement accounts, and one day, when you are ready to retire, that savings become income for you. How does that actually happen?

The go-to method of retirement saving for most white collar American workers these days is the company-sponsored 401(k) plan. Workers benefit from an easy, tax-favored way to sock away money. But the plans are not fool-proof, and they’re full of pitfalls that could trip up the novice investor.

The basic concept of retirement accounts such as IRAs and 401(k)s are an “on-your-own adventure”.  While you work, you put money in; when you retire, you take money out. For maximum benefit from your retirement income, though, you need a withdrawal strategy.

Figure out how much income you need your savings to generate every year. The amount is your total estimated expenses minus your Social Security, pensions or real estate income. Once you know how much you need each year, you can then begin to formulate a distribution strategy.

An ideal system would create a reasonable amount of retirement income that a person could actually count on, without becoming an expert on the financial markets. It would require the money to be set aside and invested in assets managed by the best in the business, and all of it at low cost.

However, a crippling combination of stagnant wages, stock market crashes, and poor savings habits have tarnished Boomers’ so-called golden years.  Pensions and similar defined benefit plans are becoming extinct.  Baby Boomers, those born between 1946 and 1964, were already well into their working careers when retirement planning started to focus on 401(k) plans instead of defined benefit plans.

The fundamental concept behind fixed income investing, especially for retirement investors, is that you are trying to preserve capital while generating enough interest and dividends to enhance your income.   The strategy is also designed to allow you to at least keep pace with inflation.

There is a growing mistrust of the financial system.  A perception that the last recession was to some extent caused by financial services industry missteps underlies the suspicion of financial advisors.  You will need to be able to cope with financial shocks.

The stock market crash in 2008 and ensuing deep recession left many Baby Boomers who were close to retirement shaken.  While 2008 did not end up taking (the Great Depression’s) path, it could have. You’d think the Great Recession would still be fresh enough in everybody’s minds that we’d be going out of our way to avoid putting ourselves through the financial wringer once again.

Having the wrong asset allocation can limit your ability to grow or protect your nest egg.  Providing a retirement plan is a generous perk for employees — not only because of the time and expense required to run the plan. Retirement plans can also be a huge liability for employers because they come with a tremendous amount of responsibility for at least some of the people acting on behalf of the plan.

Last year was a struggle for most stock pickers looking to beat the S&P 500, even more than the year before.  With so many funds struggling to beat their benchmark index, dollars have increasingly gone to those that simply try to mimic stock indexes. Index funds also have lower costs.

For the person with a day job outside of finance, trying to divine truth from the daily machinations of the stock market is at best a waste of time. At worst, it increases the odds you will be trapped by all the behavioral biases that cause people to make the wrong investing decisions – and become the dumb money of Wall Street.

If people are going to be successful in retirement, not only do they need to put away sufficient funds, they need to grow sufficiently. The key factor is what you are paying in terms of investment or management expense.

Each year, funds tally the gains and losses they made from selling stocks. They then pass on those gains to shareholders, usually in December. Investors who own funds in a taxable retirement account must pay taxes on these distributions, even if they don’t sell any shares of the mutual fund.

Fund managers struggled to keep up with their respective index. The majority of small-cap U.S. stock managers failed to keep up with the benchmark both last year and over the last decade. Same with managers who focus on mid-cap stocks. And emerging-market stocks. And real-estate investment trusts. Most large-cap fund managers fell short of the index.  The last time the majority of them beat the index was in 2007.

In all fairness, it’s been pretty easy to overlook the prime rate of late, because nothing’s happening. It’s been sitting at a rock-bottom, near-zero level for years now, with any increase contingent on the Federal Reserve raising its benchmark rate, a move they’ve been reluctant to make — until recently.

An important deadline is fast approaching for people required to tap their retirement savings for the first time.  If you turned age 70½ at any point in 2014, you must take — by April 1 of this year – your first “required minimum distribution” from your retirement accounts – generally those with tax-deferred contributions. These include, among others, IRAs, 401(k)s, 403(b)s and 457(b)s.

(There are two exceptions. The rules don’t apply to the original owners of Roth IRAs. And if you continue to work beyond age 70½, you can generally delay withdrawals from your employer’s retirement plan until after you retire.)

If you need to top up your secure income, you could use some of this pot to buy a lifetime annuity. This is an insurance policy that in return for a lump sum guarantees to pay you a regular income for life regardless of how long you live. You can arrange for this income to rise over time so that its value is not eroded by inflation. This income is secure so there is no danger of it drying up.

If you have contributed to an employer 401(k) pension where you built up your own pension pot, for those that are retiring with a defined contribution (DC) pension plan (a plan that has a fixed dollar amount and not a defined monthly payment amount), rolling your plan proceeds into an annuity is a great option.

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Sunday, March 22nd, 2015 Wealth Distribution Comments Off

The New Gold Standard

Annuities are the only product on the planet that will guarantee a lifetime income stream regardless of how long you live.  They’re not market growth products and should only be used in a portfolio as non-correlated assets.  Annuities are contractually guaranteed transfer-of-risk products. Whether you need that contractual transfer of risk guarantee is your call

One of the issues that needs to be addressed is spending retirement savings too quickly. This would be for someone who is conservative, closer to retirement and looking for a guaranteed floor of income at retirement.  The availability of deferred annuities that allow money to be drawn down in instalments instead of lump sums.  Like all insurance, they provide protection against loss in exchange for premiums or contributions.

The traditional pension plan, also called a defined benefit plan, was the gold standard of retirement benefits. It provided workers with a steady stream of retirement income after putting in a number of years on the job.  Today, most workers don’t have to worry about the funding status of their pension because they simply don’t have one. Instead, most of the employed population has access to a defined contribution plan, typically a 401(k).

What if the individual 401(k) savings approach that replaced guaranteed pensions simply doesn’t work?  Though Social Security keeps most seniors out of poverty, it provides a bare minimum of retirement income.

Unfortunately, with these plans, the burden for saving in a 401(k) rests mostly with the employee.  The fact of the matter is that Americans are responsible for creating their own financially stable retirement.  Once people retire with their sizable nest egg, decisions must be made about how to extract the money in a tax-smart, sustainable way.  For those who aren’t crazy about annuity products, there’s the daunting task of converting a nest egg into a regular income stream.

A person’s savings may need to be available for more current needs, such as leaky roofs, educational costs, and uncovered health care expenses, to name just a few. Individuals are subject to the vagaries of the stock market. Two people, each of whom save the identical amounts and invest in the identical ways can receive vastly different retirement income simply as a result of when they reach old age. For example, of the difference in the 401(k) account of one person who retired at the height of the stock boom in 2004 versus her younger brother who retired at the height of the Great Recession in 2008.

Additionally, participants in retirement savings accounts lose, minimally, a quarter of all investment gains too often hidden administrative fees, commissions and other profits deducted by financial services companies that manage the accounts.  Typically, companies that manage funds take out fees and either reduce them from gains or add them to losses before reporting quarterly earnings to account holders. Consequently most people don’t know what the management of their accounts is costing them.

Annuities are not usually recommended by financial services advisors because Annuities don’t pay quite as well as other investment strategies. Annuities companies pay a commission of roughly 2.5 per cent on money clients use to buy an annuity. By comparison, advisers and their firms could make more than that over just a few years on a fee-based account in which the client pays 1 per cent of assets annually.

Although annuities do have the reputation of being inflexible, in reality they can be tailored to the individual like no other financial product. Annuities can be bought which will pay an income to a spouse after your death for instance. Inflation – that scourge of all other investments – can be taken in your stride through an annuity, as there are products available that will pay an income which goes up in line with prices.

Annuities that provide guaranteed lifetime income, along with flexibility and liquidity, are fast becoming an essential part of a retirement income plan.  A fixed deferred annuity with a Guaranteed Lifetime Withdrawal Benefit that gives individuals – primarily pre-retirees looking to lock in future income – a secure income that is guaranteed for life, and at the same time allows assets to grow while still maintaining control of their money.

Many people are advised to buy a income annuity as one way to protect against the risk of living too long, against longevity?  The chief reason is because the income annuity provides longevity insurance — no matter how long you live, the annuity keeps paying. Individuals purchase the product with a single premium that guarantees “pension-like” income beginning at a date of their choosing and continuing for as long as the client lives.

With a annuity as the new retirement gold standard, Retirees and near retirees have confidence knowing that their principal is protected and growth of their money is guaranteed and not subjected to the ups and downs of the market.

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Tuesday, March 17th, 2015 Wealth Management Comments Off

Optimal Retirement Savings Program

Many state and local government, as well as public school and university workers are offered the opportunity to invest in what are commonly referred to as 457(b) or 403(b) plans. These defined contribution retirement plans permit largely public sector workers to defer a portion of their compensation.

To be sure, 457 and 403(b) investors generally are also participants in public pensions which will be their retirement mainstays, but pension benefits are being trimmed and likely will continue to be. A well-managed 457 and 403(b) is more important than ever.

The baby boomers joined the workforce at a time when retirement planning was often the responsibility of their employers. They are now retiring into a world where the responsibility is their own. While 401(k)s offer flexibility that allow an individual to design a retirement plan to meet their own specific circumstances, not many people will have the knowledge, time or inclination to be able to build this plan.

Unfortunately, of all the parties involved with defined contribution plans, participants (whose monies are at risk) are least knowledgeable regarding complex, opaque investment management industry practices.

Given that the majority of participants work 40-60 hours a week, it is unreasonable to expect that they will (in their spare time) acquire the expertise to skillfully sift through the numerous investment alternatives that have been provided to them and craft an optimal retirement savings program.

The hidden fees are particularly egregious, and the lack of control over retirement savings can be detrimental to consumers. The first set of fees are the ones assessed by the mutual funds, and 401(k) plans are “notorious for using very expensive mutual funds often because the plan sponsor or the employer receives a credit against the fees they pay to manage the plan.  The fees “can eat up nearly 30% of your retirement savings over ten years, even a seemingly small annual fee such as 1.27%, which is the average U.S. mutual fund fee.

In times of economic turmoil, investments in mutual funds and bonds often produce negative returns for investors, but annuity payments remain unaffected by market swings.  Finally, locking in a fixed income stream with a portion of retirement savings can free up the remainder of savings for more aggressive investment alternatives.

With the annuity’s guaranteed income stream locked in for life, the potential damage of other financial mistakes or poor investments can be mitigated. There’s a lot to like about income annuities, such as the fact that they offer a specific income stream you can count on. As we get older and are less able or willing to keep up with our investments, the arrival of regular checks can be even more valued.

Annuity contracts do have the advantage over mutual funds to defer income taxes until withdrawals occur.  You can switch portfolio allocations, rebalance your account, or even conduct a 1035 exchange from one annuity to the other without paying any taxes at all.

The thing that trips everyone up when trying to plan for income is the uncertainty about how long we are going to live. No one knows; it’s all a big guess. And guessing is the worst kind of planning as it turns out to be wrong so much of the time.

The cost of modern living coupled with the miracles of modern medical technology means that money could eventually get tight if retirees live far beyond their retirement age.  However, one popular financial product, the lifetime income annuity, seeks to eliminate the risk of outliving retirement savings.

The reason annuities are a good bet for income, to quickly recap, they work because they leverage the key risk associated with retirement planning: mortality. One of the biggest fears among the aging population is outliving retirement savings.

You might want to buy a “deferred” annuity, also referred to as “longevity insurance,” soon, though. It’s an annuity that begins payments when you’re older, such as in 10 or 15 years. If you’re pretty sure that your nest egg will last you from retirement at 65 until you’re 80, you might buy longevity insurance now that begins paying you at age 80.

Thus, you’ll never run out of money and the annuity will cost far less because you’re buying it early and it will cost the insurance company less, too. Or, if you’re still many years from retirement, you can buy a policy now that begins paying when you expect to retire.

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Wednesday, March 11th, 2015 Wealth Management Comments Off

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